For the tobacco industry, it has not been an easy few years. Pressure on valuations, litigation costs and a decline in the number of smokers have all had an impact.
But despite these underlying trends, we are seeing signs of recovery. Continued industry pricing power – cigarettes on average have three price increases a year – and the slowdown in the adoption of Next Generation Products such as Vapes are contributing to stronger earnings growth.
One company we thought warranted a closer look right now is Florida-based Vector Group (NYSE:VGR). It has low capital requirements and a history of strong earnings. At time of writing, Nasdaq is showing the dividend yield bumping up to almost 7%.
Vector Group is essentially a holdings company for Liggett Group, Vector Tobacco, New Valley and Douglas Elliman Realty. Liggett Group ranks as the fourth-largest US tobacco company; brands include Eagle 20’s, Pyramid, Montego, Grand Prix, Liggett Select and Eve. In terms of income, tobacco is by far the biggest part of the business.
Tobacco outperforms real estate at Vector Group
For the nine months ended 30 September 2020, Vector Group recorded revenues of $1.448 billion, compared to revenues of $1.464 billion for the same period in 2019. Making allowances for COVID-19, it is unsurprising that there was a drop in revenue. There was however, a more dramatic decline in net income in 2020: $60.7 million, compared to $90.3 million for the same period in 2019.
While tobacco income seems to have held up, it was the real estate side of the business that made a loss. For the twelve months ended 30 September 2020, Tobacco adjusted EBITDA was $308.3 million while adjusted EBITDA was $292.3 million.
“The year-to-date decline was partly due to the dramatic impact of the COVID-19 pandemic as well as an unusual year-over-year comparison because of the acceleration of real estate closings in New York City in the 2019 second quarter,” said Howard M. Lorber, President and CEO of Vector Group in the Q3 earnings call. This acceleration occurred in anticipation of the increase in the New York state mansion tax on residential real estate on 1 July 2019.
Another positive sign is that the tobacco side of the business has a cost advantage over the largest US tobacco companies, which relates to the Master Settlement Agreement expense (MSA). The annual cost advantage ranged between $160 million and $169 million from 2012 to 2019; equating to approximately $0.76 per pack of cigarettes.
Proceed with caution: high debt levels
But there are concerns over the group’s borrowings. In 2019, in order to reduce the level of debt – which remains high at $1.4 billion – the group cut its dividend by 50% to $0.20 per share. And interest payments are just under half annual earnings at $128 million.
Even though the industry seems to be recovering, Vector Group’s debt levels should be a warning to investors. Those looking for dividend yield might be advised to keep a close eye on the numbers.